Wednesday, March 31, 2010

Down to Earth in Germany

By Claus Vistesen: Copenhagen

(click pictures for better viewing)

It was hard not to sense that part of the IMF's recent inquiry into Germany's economy was also aimed at asking the country to eat a little bit of humble pie in the context of the ongoing difficulties facing the Eurozone. Consequently, Germany has been the poster child for the good pupil in class and an example to follow as the world seemed to have come to a near end in Greece, Spain and elsewhere. Today's hintfrom the IMF should alert us to the fact that all is not well in the so-called engine room of Germany.

(quote Bloomberg)

The International Monetary Fund cut its growth forecast for Germany after a recovery in Europe’s largest economy came to a halt, and said the government needs a “credible” plan to reduce its deficit. The IMF expects the German economy to expand 1.2 percent this year and 1.7 percent in 2011, the Washington-based lender said in a report published today. In January, the fund forecast growth of 1.5 percent in 2010 and 1.9 percent next year.

(...)

The IMF urged the German government to foster domestic consumer spending. “Strengthening domestic sources of growth will help cushion the German economy against external shocks as well as benefit the euro-area countries and the global economy by reducing trade and payments imbalances,” according to the report.

(...)

Germany mustn’t lose sight of its goal of fiscal consolidation, and policy makers must be careful as they exit from the economic support measures put in place during the global financial turbulence, the IMF said in the report.

“The authorities face the challenge of sustaining recovery while preparing to exit, as part of an international coordinated strategy, from the extraordinary measures introduced during the crisis,” it said. “Over time, fiscal policy will have to transition from support to credible consolidation.”

There are two concrete points of note above the first about how Germany should see to it that it expanded domestic demand has already gotten plenty of air time not least in the context of Merkel's continuing nein to any suggestion that Germany should aid Southern Europe in their plight through giving a little back in terms providing demand for imports.

The problem is of course that Germany is structurally positionend to be a supplier of a excess savings to the global economy through an external surplus. And the reason, well try almost four decades worth of below replacement fertility and next to non net migration, but I guess most of you know my rant here.

More importantly, this points us to the real underlying issue in the context of a global economy. In a recent very astute comment, Martin Wolf coined the concept Chermany to signify the folly of Germany and China in believing that they can demand that hitherto prolifigate deficit nations scale down while they continue ramping up external surpluses. This simply does not add up. Wolf really manages a home run with the following observation;

Behind all this is a fundamental divide. Surplus countries insist on continuing just as before. But they refuse to accept that their reliance on export surpluses must rebound upon themselves, once their customers go broke. Indeed, that is just what is happening. Meanwhile, countries that ran huge external deficits in the past can cut the massive fiscal deficits that result from post-bubble deleveraging by their private sectors only via a big surge in their net exports. If surplus countries fail to offset that shift, through expansion in aggregate demand, the world is inevitably caught in a “beggar-my-neighbour” battle: everybody seeks desperately to foist excess supplies on to their trading partners. That was a big part of the catastrophe of the 1930s, too.

So, Germany suffers from a bit of dillusion here. However, what caught my eye in particular was also the IMF's subtle but firm indication that Germany also has to tend to its public finances and now that growth seems to be less vibrant than initially assumed, it is all the more important that Germany takes proactive action sooner rather than later. And herin lies of course the rub since Germany is only surpassed by Japan when it comes to demographic ageing and thus the future liabilities of Germany are substantial.

True; Germany is moving into this with an overall lower level of debt/gdp and if there is something the Germans take pride in, it is their ability to impose self-inflicted pain and austerity to correct and to increase competitiveness and achieve growth from external sources. Yet, this brings us right back smack into the wall here since this is exactly where we don't want Germany to go, but exactly because of the demographic prospects, it is where Germany must go. In this way, Germany needs an external surplus for the same reason that Japan needs one; the expected return in the German economy and the underlying future government liabilities would not allow Germany to finance an external deficit at "acceptable" yields. This is curious in light of that that the yield on German bonds are used as benchmarks for the obvious reason that Germany is a net external lender, but what if this changed?

Of course, this is not only about Germany, but also about the majority of the Eurozone edifice which leaves, yet again the tricky question of just how we are to find those brave economies willing to stand on the opposite part of the scale as ageing and overleveraged economies crowd the savings surplus side.This is really the question we must answer (c.f. Wolf above) even if it is indeed tempting to rely on Germany to do the heavy lifting. So far, the signals from Germany have suggested that this won't happen with the good will of the German government, but ultimately it won't happen because Germany is fundamentally unable to step up to the plate and provide the capacity for the surplus of others.

One would hope that as Germany slowly wakes up to this reality and the limitations of its own economy, it will hopefully bring the country and her politicians back down to earth.